Holding Pattern and Rolling Uncertainty: Scotiabank’s Forecast Tables

• The direction of US economic and geopolitical policy is the greatest threat to the global economy. Nowhere is this more evident than in the US itself, where the volatility and speed of policy shifts, particularly as they relate to trade, are having a measurable effect on business and consumer sentiments and asset valuations. 

• We only incorporate implemented trade measures in our forecasts, avoiding speculation on future actions considering the level of uncertainty. This approach may downplay some risks as additional tariffs are likely, but it ensures accuracy based on current information. Future forecasts will be updated as new developments occur. 

• As of the day of publication, the biggest driver of a downgrade to the US economic outlook appears to be self-imposed policy volatility and ensuing unease and uncertainty. This, alongside worries about re-emerging inflation which would largely limit monetary policy’s ability to respond, as well as expected lower government spending and job losses linked to DOGE, are behind our lowered forecast of US GDP growth this year to levels well below potential growth rates. 

• These aggressive trade actions carry a cost to all those involved, with Canada being particularly vulnerable to the resulting economic uncertainty and disruptions. Tariffs implemented so far were largely in line with our holding assumptions since December, but additional broad-based tariffs in violation of CUSMA could necessitate a significant downward revision to our forecast of Canadian GDP growth. 

• The Bank of Canada and the Federal Reserve are likely to be on hold for several months as they too await to see how the tariff war unfolds, and how governments, particularly Canada’s supports firms and households through this challenging period.

To say the outlook is uncertain is about the most certain thing we can say about the world economy these days. The direction of US economic and geopolitical policy now represents the greatest threat to the global economy. This includes the US itself, and of course the most immediate object of President Trump’s focus: Canada and Mexico, but the impact of these changes and/or fear of changes is leading to a dramatic rethinking of policy frameworks in many countries. This is evident, for example, in the way Europe is approaching continental economic and defence policy, where it is now clear that European countries, led by Germany of all countries, is about to embark on a significant investment program to strengthen their economies and shore up their defenses. It is also evident in how markets have begun pricing in future relative growth outcomes in asset prices, with US equity markets sharply underperforming most other advance economy markets, following a long period of exceptional US market performance relative to peers.

A principle challenge in mapping the way forward for the outlook lays in identifying the way forward on US trade policy. It seems likely that further tariffs are coming in addition to those that have already been implemented. Where those will eventually settle is anyone’s guess. For the time being, tariffs have largely been delayed for Canada and Mexico, tariffs are on for China, and tariffs are in place for steel and aluminum imports into the US. President Trump has repeatedly indicated that April 2^nd will see another round of tariffs: full tariffs of 25% on non-energy, non-potash exports from Canada and Mexico to the US, reciprocal tariffs on every country exporting to the US, and a promise to add stacking tariffs on specific products like pharmaceuticals, copper, lumber, autos and a few other things. While the threat of tariffs must be taken seriously, these tariffs will cause significant harm to the US economy even before other countries retaliate. There is thus reason to doubt their implementation, or at the very least the duration of their implementation. This has been evident in the on-again, off-again implementation of tariffs on Canada and Mexico so far. And may be even more evident as the US, which represents only 16% of the world’s GDP in Purchasing Power Parity terms, gets ready to take on the world and the retaliatory consequences of their actions. While there is great uncertainty about the actions to come, there can be no uncertainty that aggressive trade actions by the US and retaliation from impacted countries will impose significant economic costs to all involved, with consequential impacts to asset and commodity markets.

Given how volatile the policy environment promises to be, we will only incorporate implemented trade measures in our forecasts going forward. While this will likely mean that we downplay some risks to the outlook, it is impossible to speculate on what will be done and how long it will last. We will update future forecasts as developments occur. For this forecast, we thus incorporate the current set of tariffs on Canada, Mexico and China, with assumptions on CUSMA carveouts as is current US policy, 25% tariffs on steel and aluminum, and retaliatory tariffs on the US imposed by countries that have already done so. We also incorporate the trade policy uncertainty index, which is an important driver of outcomes. We have done this since December but that index keeps rising and so we adjust forecasts accordingly.

As it turns out, the tariffs currently in place align closely with our previous holding assumptions we have had since December on tariffs imposed on Canada. We had chosen at the time to assume tariffs of 5% of 50% of Canadian exports, for an effective tariff increase of 2.5% on all US-bound exports. Our rough estimate of the tariffs currently being imposed on Canada once assumptions are made for what can come in under CUSMA preferences, points to a tariff increase of about 2.7% on US-bound exports. Additionally, China has imposed its own tariffs on certain Canadian goods, leading to an overall effective tariff increase of about 2.6% on all Canadian exports.

Despite the fears of damage on the Canadian, Mexican and global economies, the US appears to be suffering the most from its self-imposed policy volatility for the time being. As a result, we have scaled back our forecast for US growth below that of Canada this year. The unease and uncertainty felt north of the border is also felt by our southern neighbours. Measures of business and consumer sentiment are falling fast. Worries about rising inflation are increasing even more rapidly. Concerns about the broad set of policy reforms linked to DOGE, lower government spending (which has yet to materialize…), job losses and fears of job losses are mounting. Add to that the evident disruptions to business models from tariffs, comments from President Trump and his cabinet members dubiously warning of short-term pain for longer-term gain, the factors weighing on the outlook are mounting. Some analysts are now once again putting odds on a US recession. That being said, hard economic indicators so far do not suggest these factors are having large impacts on activity yet other than on the trade side. There, US businesses are trying to get ahead of potential tariffs by running up huge increases in imports, which are up roughly 25% in January, the most recent month for which we have data. We expect growth of 1.4% this year in the US followed by an expansion of 1.6% next year. While not a recession, these growth rates are well below potential growth rates.

In Canada, there are clear indications of worries on the part of Canadian households and firms. For the time being though, tariff outcomes are roughly in line with our expectations and thus do not represent a big change in our outlook. As noted above, we will update tariff assumptions as they are implemented in the US. Clearly, broad-based tariffs on Canadian and Mexican goods that are in clear violation of CUSMA, would lead us to lower our growth forecasts. It may well be in those circumstances that Canadian real GDP growth would fall below that of the US this year. As it stands, the sharp reduction in policy rates continue to provide some insulation against tariff-related uncertainty and damage, but there is no doubt the economy is softening given the economic aggression from the US. We anticipate growth of 1.7% this year and 1.5% next year for the moment. Those views will be updated as developments occur.

There are several yet unknown developments that will be critical to the outlook and central bank responses. First of course are the tariffs. Will they materialize, if so, what will they look like, and how long will they last? Secondly, how will countries retaliate, and will that prompt a series of escalating retaliatory tariffs? Canada has already announced tariffs on $155 bn worth of US imports in retaliation (of which about half has been implemented). Third, governments work to protect their citizens from the damages of a tariff war and geopolitical upheaval. Europe is in the early stages of a process that could see transformational investments. Canada has indicated that fiscal support will be deployed to cushion the blow of tariffs if needed, while a political consensus seems to be forming to aggressively tackle the constraints that have restrained investment growth. Finally, how will inflation expectations evolve considering the tariff threat? Rising inflation expectations will seriously impact central bank flexibility in dealing with the inflation and growth consequences of developments. Inflation expectations are already on the rise in Canada based on the Bank of Canada’s survey and are sharply higher in the US based on the University of Michigan survey.

Each of these stages comes with potentially large impacts on inflation and the outlook more broadly. For Canada, we think the Bank of Canada will wait and see how these various factors play out before it decides to alter interest rates from their current level. The balance of risks suggests the odds of lower rates may dominate over the course of the next several months, but there is a non-zero chance that Governor Macklem may need to raise interest rates if inflation outcomes merit it. He has, after all, indicated a few times now that he will not let a tariff shock become an inflation shock. In the US, the inflation starting point is more problematic, with inflation still some distance from the Federal Reserve’s objective. With inflation expectations sharply rising, we expect the Federal Reserve will remain on hold through the first half of the year even though growth is slowing more rapidly than expected so far this year. The Fed has little ability to respond to lower growth in the short run given what we still consider to be a challenging inflation outlook. With the policy rate still well above neutral and the economy switching from excess demand to excess supply late in 2025, the Fed will need to normalize borrowing costs. We forecast 50 bps of cuts in the second half of this year followed by another 50 bps of cuts in 2026.